Global Economics

London's Real Estate Boomlet

Americans who are lying awake at night worrying that the prices of their homes will fall off a wall like Humpty Dumpty can take some comfort in the experience of Londoners. After house prices in the British capital racked up double-digit gains seven years in a row through 2003, most forecasters predicted a nasty snapback. So far it hasn't happened. In fact, there are signs that prices are beginning to resume their upward climb.

Sure, last year London's real estate market saw a sharp slowdown. Buyers, no doubt influenced by all the crashonomics, kept their powder dry. But that only caused demand to build up, and now the spark is back. First-quarter sales grew 41% from a year earlier, and prices are on track to grow 6% or more this year.

NOT-SO-HUMBLE ABODES. It's starting to feel like the feeding frenzies of three or four years ago. Instead of seeing houses languishing on the market, brokers -- or estate agents, as they are called in England -- say they can't find enough to sell. "There is an incredible shortage of property," says Lisianne Newman, director of Goldschmidt & Howland estate agents in Hampstead, a tiny North London neighborhood. "That has led to price rises of about 10% in the last three months throughout the entire market."

Newman says the action is hottest for houses priced at around 1 million pounds, or about $1.9 million, or higher. Each of those houses and well-appointed apartments attracts such a crowd that the agency is seeing multiple would-be buyers submitting sealed bids in envelopes.

Brokers and economists attribute the change in psychology to several factors. With private equity and M&A in high gear, the City, London's financial center, had a strong year in 2005. That led to big bonuses in early 2006 from banks and other financial institutions. Russians and other newly wealthy foreigners consider a London house an ideal place to stash some spare cash. And when you consider that Brits themselves like nothing better than to put money into property and that London will host the summer Olympics in 2012, you have the key planks in a possible floor under the city's prices.

RATE CUT. It also helped that in August the Bank of England cut rates to 4.5%, down from 4.75%. Potential buyers had been spooked by Bank of England Governor Mervyn King's earlier warnings that the market looked dangerously frothy. But the bank's trim suddenly took the worry out of the rate outlook. "That removed a lot of uncertainty from the market," says Ed Stansfield, property economist at Capital Economics in London.

Capital Economics counted among the many real estate bears, forecasting a steep drop of 20% in British house prices -- but the dreaded bust has yet to materialize. According to the Halifax Index, kept by mortgage lender HBOS, prices in Greater London rose by an average of 2.1% in 2005. That may have been disappointing to sellers following the 16.6% pyrotechnic gains of 2002 and a 12.8% rise for an encore in 2003, but it was far from a plunge off a cliff. Now Capital Economics is forecasting 6% average price increases this year for London and 3% to 4% for 2007.

Brokers say the current boomlet began last fall after the Bank of England cut rates. It is too soon to tell whether it will last, but posher neighborhoods are showing signs of gathering strength. In the verdant west London borough of Richmond upon Thames, for instance, the average selling price of a stand-alone house was 29% higher than a year ago in the first quarter, or $1.89 million, according to the Land Registry, the official recorder of property transactions.

RISKINESS LURKING? In Camden, where Hampstead is located, the average selling price of a residence rose 18% -- to $943,000 -- from the fourth quarter of 2005 to the first of 2006. Sales volumes in greater London rose 41% year on year in the first quarter. With price increases in the less swanky neighborhoods more restrained, the Halifax says overall London prices have risen 7.2% over the last 12 months.

Of course, London house prices can and do fall. They did it for four years in a row in the early 1990s, and some homeowners didn't match the prices they paid in the 1980s property boom until near the end of the last century.

There's cause for caution today, too. Stansfield of Capital Economics, for instance, says it now costs 53% of an average Londoner's income to finance a home purchase. That's well above the 30-year average of 45%.

LOOKING HEALTHY. "The risks are strongly biased to the downside. You obviously couldn't rule out fairly significant falls in prices," says David Miles, a Morgan Stanley economist specializing in Britain.

One reason: The new boom has caught Mervyn King's attention and helped make it likely the next move on interest rates will be upward. "The level of house prices still seems remarkably high," said King recently. But today's British economy, with its relatively low rates and robust employment numbers, still looks healthy. It will take more than a few cautionary words from King to scare off house-mad Londoners.